What Is a Seed Round?

A seed round is a startup's first significant financing from outside investors. The company sells a small slice of its future ownership, or a contract that turns into ownership later, in exchange for cash to build the product and find its first real customers. It sits after any informal pre-seed money and before the first institutional venture round, usually called Series A.

There's no legal definition of the term. Amounts, investors and paperwork vary a lot by country, industry and year. As Paul Graham wrote in his essay on startup funding, the word covers a broad range: to some VC firms a seed round means $500,000, but to most startups it means several months' living expenses. This article describes common US practice and is general education, not legal or financial advice.

One distinction up front. This article is about the financing event: who writes the checks, how the deal is structured and what the money is spent on. The company that receives it, and the milestones it's chasing, are covered in what a seed-stage startup is.

Who Invests in a Seed Round

Seed money comes from a handful of investor types, and a single round often mixes several.

Graham describes angels as individual rich people and notes that their contacts and advice can matter more than the money. He also observes that seed firms will probably have set deal terms they use for every startup they fund, which is why accelerator deals tend to look alike from one company to the next.

Many seed rounds also have a lead investor, the one who negotiates the terms and sets the tone for everyone else in the round. Smaller participants then follow on the same terms.

How a Seed Round Is Structured

The hardest part of pricing a seed company is that there's almost nothing to price. That's why the US Securities and Exchange Commission notes that convertible notes and SAFEs are used in early rounds because of challenges valuing a company early in its life cycle. There are three common structures.

SAFEs

A SAFE is, in the SEC's words, an agreement in which the company promises the investor a future ownership interest if certain triggering events occur. Y Combinator, which created it, says a SAFE converts into shares automatically when the company raises a priced round. It carries no interest and no maturity date, and it usually includes a valuation cap, a discount, or both.

Convertible notes

A convertible note is, per the SEC, a loan made by an investor to a company that can be converted into a different security. Unlike a SAFE it's debt: interest accrues and there's a maturity date, which creates a repayment question if no later round arrives in time.

Priced equity

In a priced seed, investors buy shares (usually preferred stock) at an agreed price per share, which means the company and investors settle on a valuation on day one. The terms are heavier: a term sheet, negotiated rights, and often a liquidation preference. Cooley GO notes that its Series Seed document set, created through a collaboration among lawyers and investors led by Ted Wang, aimed to reduce the cost of fundraising for emerging companies by standardizing the core legal documents, and that the set has become one of the go-to sets of documents for many early-stage equity financings.

Comparing the three

A trade-off sits under the table. Deferring the price makes the round faster and cheaper, but it postpones the dilution math. Several SAFEs or notes stacked at different caps can add up to a bigger ownership stake than founders expected once the next round prices, so model them on a cap table before signing. The mechanics of pre-money vs post-money valuation matter here, since YC's standard SAFE uses a post-money cap.

What Seed Money Is Used For

Seed money isn't a reward for past work. It's fuel for a specific plan, typically 12 to 24 months long. Common uses include:

• Product development. Engineers and designers to turn a prototype into something people use daily.
• First go-to-market. Founder-led sales, early marketing tests, and customer success for the first accounts.
• Early hires. A small team of generalists, often with part of their pay in options from the employee option pool.
• Legal, accounting and tooling. Company setup, contracts, a bookkeeper, and basic software.
• Reserve. A cushion so a slow quarter doesn't end the company.

A purely hypothetical split, with round numbers, shows the logic. Say a company raises $2,000,000 and plans 18 months of operations: roughly $1,200,000 on a small team's salaries, $400,000 on product, infrastructure and tools, $200,000 on customer acquisition experiments, and $200,000 held in reserve. That works out to about $111,000 of spend per month, which is the company's burn rate, and about 18 months of runway. The figures are illustrative arithmetic only.

What Seed Investors Expect to See

Seed investors are betting on thin evidence, so they look at different things than later-stage investors do. Graham's view is that seed investors usually care less about the idea than the people. Beyond the team, investors commonly look for:

1. A clear problem and a defined first customer group, sometimes called a beachhead market.
2. Early proof of demand, such as a working product, repeat usage, pilots or first revenue.
3. A market large enough to matter, often framed with TAM, SAM and SOM.
4. A believable path to an exit. Graham notes that investors need to get their capital back, so they'll only consider companies that could get bought or go public.
5. A plan for the money, including the milestone it should reach and when the company will raise again.

Investors also check the basics in a light form of startup due diligence: who owns what, whether the founders' equity is properly documented, and whether any earlier SAFEs or notes are outstanding.

Seed Round vs Pre-Seed vs Series A

The labels are informal and overlap, but the usual progression looks like this.

For what follows the seed, see Series A, B and C funding. A seed round is also not the only way to run the early stage. Some founders skip it and self-fund.

Common Mistakes in Seed Rounds

• Raising without a milestone. Money should buy a specific proof point. Without one, the company just burns toward another raise.
• Stacking instruments unmodeled. Different caps on different SAFEs or notes can combine into surprising dilution.
• Raising too little to reach the next round. If cash runs out first, the company may need a bridge round on weaker terms.
• Giving away pro rata rights carelessly. Rights to invest in later rounds are valuable and constrain who can join.
• Skipping legal review. Securities rules differ by country and by state. Have counsel review every instrument before signing.

Key Facts

• A seed round is a startup's first significant outside financing, and the term has no legal definition.
• The SEC says convertible notes and SAFEs are used in early rounds because of challenges valuing a company early in its life cycle.
• Y Combinator says the SAFE was created at YC by Carolynn Levy in 2013 and converts automatically when a priced round occurs.
• A convertible note is debt with interest and a maturity date. A SAFE has neither.
• Paul Graham writes that seed investors usually care less about the idea than the people.
• Cooley GO describes the Series Seed documents as a go-to set for many early-stage equity financings.

Related Reading

• What Is a SAFE?
• Convertible Note
• Angel Investor
• Series A, B and C Funding
• Seed-Stage Startup
• Pre-Money vs Post-Money Valuation